Outlook Still Dismal for Europe’s Banks

A short position in 3 European banks may be a very good idea

I admit, I am with a big crowd right now and enjoying it. I am in London for the Olympic Games and some sleuthing on the European economy. Both are going well.

After three days of maddening efforts I finally was able to buy a ticket — please do not ask what it cost — and was at the swimming venue last evening to see the Americans pick up pick up two golds a bronze and a silver — including Michael Phelps’ medals that made him the all-time leading gold medal winner and the all-time leading medal winner.

The woman sitting next to me, a senior executive for the power company supplying the games, was herself an Olympian in 1984. Before the evening was done I spent considerable time with an oil trader and an options trader — I did say I was here to work as well.

The economy here — Europe, not just the UK — is soft and getting softer. At least one-third of the seats at the swimming venue were empty, I bought mine from a large sponsor unloading tickets originally procured for guests who did not come to the Games.

Restaurants and hotels are seeing traffic lighter than usual — not just for the Olympics, for this time of year in general. And discussions with people in business here — in telecom, in travel, in core industry — tell me things are continuing to slide. Even the Germans I have spoken with are fearful the recession that is being felt through most of the Continent has begun to touch their country.

Vulnerability of banks

And that is where we find another crowd — those perma-bulls on Wall Street who believe Germany is immune from the recession and the financial crisis. Not only is this not true, German banks are among the most vulnerable to financial crises.

They are very highly leveraged — that being the ratio of loans to core capital — among state banks, leverage may be greater than the number that brought down Lehman Bros. The big bank in Germany, Deutsche Bank (NYSE:DB), just missed estimates and had a downbeat forecast for the rest of 2012. The bank said it was reducing its leverage and shedding assets, and that means lower profits for the rest of the year. They should have said the rest of the decade, for that is closer to reality.

I write this now because the banks — their stocks — popped up on the news that the European Central Bank will “do whatever it takes” to help banks out. That may be true when it comes to short-term loans, but over time the big European banks will need more capital and that means diluting shareholders. When their charts top out, look at puts on DB, UBS (NYSE:UBS) and Bank Santander (NYSE:SAN) — three possibly great shorts waiting to happen.

This article was originally written by Michael Shulman for Traders Reserve